Student accountant articles: visit the ACCA website, www.accaglobal.com to review the article on ‘reward schemes for employees and management’.
1 Assumed knowledge
7 builds on your knowledge of Hopwood’s management styles from PM.
2 Introduction
This looks at the link between human resource management and performance measurement and considers the impact of the employee reward system on the behaviour of employees and on the performance of the organisation as a whole. It also discusses the accountability issues that might arise from performance measurement systems and looks at how management style needs to be considered when designing an effective performance measurement system.
3 Introduction to human resource management (HRM)
3.1 Definition of HRM
HRM is the strategic and coherent approach to the management of an organisation’s most valued assets: the people working there who individually and collectively contribute to the achievement of its objectives for sustainable competitive advantage (Armstrong).
HRM includes the recruitment of employees, the development of policies relating to human resources (e.g. reward systems) and the management and development of employees (e.g. through training and development and through the appraisal system).
3.2 Importance of human resources
Human resource management has grown in importance from the traditional view of the personnel department, whose role was primarily seen as that of hiring and firing employees. Today, employees are seen less as an expensive necessity but as a strategic resource that may provide the organisation with competitive advantage.
Illustration 1 – Importance of human resources
In service industries, such as restaurants, employees have direct contact with customers. Having employees that are friendly and helpful has a large impact on how customers will view the business. Teams must be passionate about delivering an amazing guest experience to each and every customer and they should be provided with the right tools and training to deliver this brilliant experience.
An organisation uses HRM to ensure that it has the correct people in place to fulfil its strategic and operational objectives.
Illustration 2 – HM and competitive advantage
Some examples of the link between HRM and strategy are as follows:
If competitive advantage is sought through differentiation then HRM needs to ensure that high quality, skilled staff are recruited, that these staff are given the freedom to be creative and innovate, that a culture of service and quality is prevalent, and that rewards are geared towards long-term success and beyond short-term financial measures.
On the other hand, if a strategy of cost leadership was pursued, then HRM needs to focus on recruiting low skilled workers, providing repetitive, simple tasks, minimising staff numbers, providing strict controls, and focusing appraisals and rewards on short-term cost measures.
Test your understanding 1
Required:
If an organisation planned to grow through acquisition, how might HRM contribute to the achievement of this strategy?
The problem with human resources is that they require more management than other resources since humans are complex, emotional creatures.
4 Reward schemes for employees and managers
4.1 Introduction
A reward system refers to all the monetary, non-monetary and psychological payments that an organisation provides for its employees in exchange for the work they perform.
4.2 The importance of target selection
It is important that appropriate targets (performance measures) are set for the employee. Targets should be:
- Relevant to the organisation’s overall objective, e.g. if the organisation has an objective of 100% quality then an individual production worker may be set a target to produce products with zero defects. (It is worth noting that quality initiatives are often undermined by targets that focus on short-term profits).
- Achievable – employees may be unmotivated if they consider targets are very difficult or impossible to achieve, e.g. zero defects may be seen as impossible. However, it is worth noting that the same may be true if targets are too easy to achieve.
- Controllable – the individual will be unmotivated if they feel they can’t control the target set, e.g. a production worker may not be responsible for defects if poor quality materials are purchased.
- Prioritised – employees will be overwhelmed and hence unmotivated if they are set a large number of targets.
- Rewarded – employees should be rewarded for achieving the target (s)
4.3 The purpose of reward systems
There are a number of purposes of reward systems:
- To further the organisation’s objectives through the achievement of the employee’s objectives. The two sets of objectives should be aligned. Importantly:
– ‘What gets measured gets done’.
– ‘What gets measured and fed back gets done well’.
– ‘What gets rewarded gets repeated’.
Illustration 3 – Alignment of goals
The reward scheme should support the organisation’s goals and must be consistent with its strategy. For example, the UK supermarket Waitrose has a strategy of differentiation. Staff receive generous pay and benefits which are linked to the achievement of certain skills and pre-agreed targets. The supermarket, Lidl, on the other hand has a strategy of cost leadership. It has a simple reward scheme offering fairly low wages as staff are less skilled and new staff are easy to recruit and need little training.
- To ensure the recruitment and retention of appropriately skilled staff.
- To provide a fair and consistent basis for rewarding employees.
- To motivate staff and maximise performance.
Illustration 4 – Vroom’s expectancy theory
Motivated staff are more likely to achieve targets and organisational goals.
Vroom believed that people will be motivated to do things to reach a goal if they believe in the worth of that goal and if they can see that what they do will help them in achieving it. Vroom’s expectancy model is stated
as:
Force = valence × expectancy
where:
Force = the strength of a person’s motivation.
Valence = the strength of an individual’s desire for an outcome.
Expectancy = the probability that they will achieve that outcome.
Reward schemes and employee motivation
A well known theory of motivation is Maslow’s hierarchy of needs.
Maslow stated that people’s wants and needs follow a hierarchy. As employees become progressively more highly paid, monetary rewards become less important as other needs such as recognition and an ability to achieve one’s potential become more important.
- To reward performance through promotion or progression.
- To control salary costs.
- To comply with legal requirements and ethical obligations.
Illustration 5 – Reward systems and ethics
Awarding huge salaries and large bonuses to the senior executives of big companies may be seen as unethical when the economy is in recession and there is a climate of job cuts and pay freezes. However, others would argue that in order for a company to survive and thrive, the best senior executives must be attracted and retained. Therefore, executives must be offered a competitive and attractive reward package.
- To ensure the employees’ attitude to risk is aligned with that of the organisation.
Illustration 6 – Reward schemes and risk appetite
As mentioned above, one of the problems associated with linking reward schemes to performance is that employees will prioritise the achievement of their reward which may impact their risk appetite.
UK banking executive’s pay has received widespread political and media coverage since the 2008 financial crisis. It is argued that performance related bonuses have incentivised excessive risk taking and short-termism and there are widespread concerns that remuneration policies may have been a contributory factor to the financial crisis.
4.4 Methods of reward
Employee rewards fall into four categories:
- Basic pay – this is the minimum amount that an employee receives for working in an organisation and is determined in a number of ways such as market rates or job evaluation. Hourly rates or fixed annual salaries may be paid. Basic pay may be supplemented by other types of remuneration.
- Performance-related pay – pay is based on the level of performance. Rewards may be based on individual, group or organisational performance, all of which aim to motivate employees to work harder. (The types of performance-related pay are discussed below).
- Benefits – a wide range of rewards other than wages or pensions, such as company cars or health insurance. These can provide additional incentives at a lower cost and can be designed in a flexible way to suit the individual employee.
- Share options – these give employees the right to purchase shares at a specified exercise price at a specified time in the future. Share options will generally be exercisable on a specific date. They are often given to senior managers and should motivate them to increase share price. However, there is an argument that many of the factors that influence share price will be outside of the manager’s control or that (previously risk averse) managers could be tempted to take risks in the hope of increasing the share price.
Test your understanding 2
Required:
Evaluate the four different reward methods.
4.5 Types of performance-related pay
There are a number of different types of performance-related pay:
- Piecework schemes – a price is paid for each unit of output. Often viewed as a fair system but quality control will be required.
- Individual performance-related pay – a pay rise or bonus is given to an employee on achievement of pre-agreed objectives or based on the assessment by a manager. Advantages include the ability to align individual objectives with organisational goals and the controllability of rewards by the employee. However, such schemes may result in a lack of teamwork and in tunnel vision (sole concentration on areas which are measured and rewarded).
- Group performance-related achievement of group targets. as fair by employees.
pay – rewards are based on the Encourages teamwork but may not be seen
- Knowledge contingent pay – for example, an accountant may receive a bonus or pay rise on passing their ACCA exams.
- Commission – normally used for sales staff and is based on a percentage of their sales. Can motivate staff but may lead to short termism and manipulation of results.
- Profit-related pay – part of the employee’s remuneration is linked to organisational profit. Can motivate employees to increase company profit and increase loyalty but may lead to short termism and lack of motivation if employees feel they have no control over organisational profit.
4.6 Benefits and problems of linking reward schemes to performance measurement
| Benefits of linking reward schemes | Potential problems of linking | |||
| to performance | reward schemes to performance | |||
| | It gives individuals an incentive | | Employees will prioritise the | |
| to achieve a good performance | achievement of their reward | |||
| level since they know that this | which may impact their risk | |||
| will be rewarded. | appetite. Employees may | |||
| | Schemes based on shares can | become too cautious and risk | ||
| averse or conversely they may | ||||
| motivate employees/managers | ||||
| take bigger risks. | ||||
| to act in the long-term interests | ||||
| of the organisation. | | Employees may be unmotivated | ||
| | Effective schemes also attract | if they feel that they were | ||
| penalised financially for | ||||
| and keep the employees | ||||
| circumstances outside of their | ||||
| valuable to an organisation. | ||||
| control, e.g. an employee may | ||||
| | By tying an organisation’s key | have hit their quality target but | ||
| performance indicators to a | did not receive a reward | |||
| scheme, it is clear to all | because the company’s annual | |||
| employees that performance | performance was poor. | |||
| creates organisational success. | | Employees may become highly | ||
| | ||||
| By rewarding performance, an | stressed if a significant | |||
| effective scheme creates an | proportion of their income is | |||
| organisation focused on | performance related. | |||
| continuous improvement. | | Employees will have an extra | ||
| incentive towards the | ||||
| dysfunctional behaviour, i.e. | ||||
| making decisions that are not in | ||||
| the best interests of the | ||||
| business. | ||||
| | Should targets be based on | |||
| individual, team, division or | ||||
| group performance? | ||||
Question practice
The question below is an extract from a past exam question. Make sure that you take the time to attempt the question and review the answer.
Test your understanding 3
Lincoln & Lincoln Advertising (LLA) is an advertising agency based in Veeland, which is a large well-developed country considered to be one of the wealthiest in the world. LLA operates out of three regional offices (North, East and West) with its head office functions based in the East offices. The business offers a wide range of advertising services:
Strategic: Advising on an overall advertising campaign (mix of advertising channels and overall themes)
Buying: Advising and buying advertising space (on television, radio, websites and in newspapers and magazines); and
Creative: Designing and producing specific adverts for the customers’ use.
The company is one of the three largest agencies in Veeland with many years of experience and many awards won. Competition in advertising is fierce, as advertising spending by businesses has suffered recently during a general economic downturn. Most new business is won in tender competitions between different advertising agencies.
Remuneration policy and regional offices
There are broadly five grades of staff at each regional office. The following is an outline of their remuneration packages. (The head office staff are treated separately and are not part of this exercise.)
Senior management
All staff at this level are paid a basic fixed salary, which reflects industry norms over the last few years, plus a bonus dependent on the net income of their office.
Creative staff
The ‘creatives’ are on individual packages which reflect the market rates in order to recruit them at the time that they were recruited. Some are fixed salary and some have a fixed element plus a bonus based on their office’s revenues.
Buying staff
The buyers are paid a fixed salary plus a bonus based on the prices for advertising space that they negotiate compared to the budgeted cost of space. The budget is set by the finance team at head office based on previous years’ experience and their forecast for supply and demand in the year in question.
Account management staff
Account management handles relationships with clients and also develops new clients. They are paid a fixed market-based salary.
Administration staff
These staff are paid the market rate for their jobs as a fixed salary based on hours worked.
Required:
Using the information provided, evaluate LLA’s remuneration policy suggesting changes as appropriate.
(10 marks)
- Accountability issues arising from performance measurement systems
In order to ensure that an employee is motivated to meet the performance measures (targets set), the targets need to be:
- clear (SMART) and
- linked to controllable factors.
As mentioned previously, employees will be unmotivated if they feel they are penalised for circumstances outside of their control.
Illustration 7 – Berry, Broadbent and Otley
There are many ways in which poorly designed performance measurement can result in wrong signals and dysfunctional behaviour. Berry, Broadbent and Otley identified the following problem areas:
- Misrepresentation – ‘creative’ reporting to suggest that a result is For example, a manager may report that 98% of customers were ‘satisfied’ or ‘more than satisfied’ with the level of service they were provided with. However, on further investigation it may be found that feedback was only sought from a small selection of customers.
- Gaming – is dysfunctional behaviour where an individual manager is trying to meet their individual targets while ignoring the good of the whole organisation. For example, a manager may decide to cut divisional investment to boost divisional return on investment but this may result in a long-term fall in profits.
- Misinterpretation – failure to recognise the complexity of the environment in which the organisation operates. For example, looking at the financial aspects of performance a manager may be assessed as performing well. However, on further investigation it may be discovered that non-financial factors such as customer satisfaction are less favourable and therefore performance has been misinterpreted.
- Short-termism (myopia) – leading to the neglect of longer-term Financial measures such as return on capital employed (ROCE) may lead to short-termism. The use of a mix of financial and non-financial measures may lead to an improved focus on long term success.
- Measure fixation – measures and behaviour in order to achieve specific performance indicators which may not be effective. For example, an excessive focus on cost cutting to the detriment of quality and long term performance.
- Tunnel vision – undue focus on stated performance measures to the detriment of other areas. For example, an undue focus on ROCE to the detriment of employee satisfaction due to their needs, for say training or competitive remuneration, not being met.
- Sub-optimisation – focus on some objectives so that others are not For example, a focus on winning new customers may result in a reduced focus on the satisfaction of existing customers.
- Ossification – an unwillingness to change the performance measurement scheme once it has been set up, especially when it shows that good or adequate results are being achieved. The example of customer surveys being sent to only a select group of customers is also relevant here.
A number of actions might be taken in order to minimise the impact of imperfections that may exist within the performance measurement system. These methods will be explored in later s.
6 Management styles
Hopwood identified three distinct management styles of performance appraisal. The style needs to be considered when designing an effective performance measurement system.
Hopwood styles
Budget constrained style
The manager’s performance is primarily evaluated upon the basis of his ability to continually meet the budget on a short-term basis. The manager will receive unfavourable feedback from his superior if, for instance, his actual costs exceed the budgeted costs, regardless of other considerations.
Profit-conscious style
The manager’s performance is evaluated on the basis of his ability to increase the general effectiveness of his unit’s operations in relation to the long-term purposes of the organisation.
Non-accounting style
The budgetary information plays a relatively unimportant part in the superior’s evaluation of the manager’s performance.
| Budget | Profit-conscious | Non-accounting | ||||
| constrained | ||||||
| Characteristics | Pressure to hit | Focus on longer- | | Little | ||
| short-term | term | emphasis on | ||||
| financial targets. | performance. | financial | ||||
| performance. | ||||||
| Look at non- | ||||||
| financial | ||||||
| aspects | ||||||
| instead. | ||||||
| Performance | Short-term | Measures of | Non-financial | |||
| measurement | financial | long- term | measures such | |||
| systems | performance is | profitability may | as customer | |||
| measured using, | be used. For | satisfaction, | ||||
| say, ROCE or | example, the net | employee morale | ||||
| annual gross | present value | or innovation may | ||||
| profit. | (NPV) of a | be used. | ||||
| project over its | ||||||
| entire life may be | ||||||
| used when | ||||||
| making | ||||||
| decisions. | ||||||
| Advantages | Should ensure | Give flexibility to | | Focus on | ||
| short- term | go ‘off plan’ if | causes rather | ||||
| targets are met. | justifiable. | than effects. | ||||
| | Targets may | |||||
| be more | ||||||
| meaningful to | ||||||
| staff. | ||||||
| Disadvantages | | Short-termism | Loss of short- | Financial | ||
| (e.g. cost | term control. | implications of | ||||
| cutting). | behaviour may | |||||
| | Results may | be neglected. | ||||
| be ‘distorted’. | ||||||
| | Stress for | |||||
| employees | ||||||
| and difficult | ||||||
| working | ||||||
| relationships. | ||||||
| | Lack of | |||||
| flexibility. | ||||||
| | Stifles | |||||
| ingenuity. | ||||||
7 Exam focus
| Exam sitting | Area examined | Question | Number of |
| number | marks | ||
| Sept/ Dec 2017 | Management styles | 3(c) | 10 |
| Mar/June 2016 | Reward scheme | 1(v) | 12 |
| assessment | |||
| Mar/June 2016 | Reward systems | 2(b) | 11 |
| June 2015 | Management styles | 4(c) | 10 |
| June 2015 | Reward systems | 3(c) | 9 |
| June 2014 | Appraisals | 2(c) | 8 |
| December 2012 | Reward schemes | 1(iii) | 10 |
| December 2011 | Performance appraisal | 4(b) and (c) | 12 |
| system, Hopwood |
Test your understanding 1
HRM may have to:
- plan potential redundancies when staff are measured
- facilitate and manage the changes in culture and performance that are necessary
- ensure that corporate goals and missions are understood and communicated
- unify reward systems
- redesign jobs
- plan training.
This is just one further example of the link between HRM and strategy, but it should illustrate how HRM plays a role in contributing to the achievement of an organisation’s objectives.
Test your understanding 2
| Advantages | Disadvantages | ||||
| sick pay | | Easy to administer. | | Does not motivate | |
| | Basic employee | employees to | |||
| achieve strategy. | |||||
| needs taken care of. | |||||
| | Does not motivate | ||||
| employees to | |||||
| improve | |||||
| performance. | |||||
| Performance- | | Motivates employees | | Can be subjective | |
| related pay | to achieve strategy. | and inconsistent. | |||
| | Motivates employees | | Can be viewed as | ||
| to improve | unfair if based on | ||||
| performance. | team/company | ||||
| performance. | |||||
| | Stressful for | ||||
| employee if they rely | |||||
| on this to pay for | |||||
| basic needs. | |||||
| 7 | ||||||||
| Benefits | | Can be tailored to the | | Employees may not | ||||
| individual employee. | want. | |||||||
| | Does not motivate | |||||||
| employees to | ||||||||
| achieve strategy. | ||||||||
| | Big additional cost. | |||||||
| Share | | Should motivate | | Factors that | ||||
| options | employees to | influence share price | ||||||
| increase share price. | may be outside of | |||||||
| employee’s control. | ||||||||
| | May tempt managers | |||||||
| to take excessive | ||||||||
| risks. | ||||||||
Test your understanding 3
Remuneration packages
Generally, using industry norms as a basic benchmark will help to ensure that staff are kept broadly happy, although it will not motivate them to outperform their peers.
Taking each of the staff levels in turn:
Senior management
Their basic salary reflects historic norms and the bonus should motivate performance. It is notable that no account is taken of the different economic conditions that each office may find itself in and so there may be resentment from those in offices where the general economy is doing poorly to those who are in a region with good performance and so profits are growing easily. It may be worthwhile trying to benchmark the performance of each office against its regional competitors, although it can be hard to obtain such detailed information.
Creative staff
The creatives’ packages are set when recruited. This could lead to a loss of motivation, especially for those who get only a fixed salary. If a bonus is paid, then it is currently based on revenue and not profits and so there is no mechanism to control costs on projects with these employees.
There will be tension between the need for imaginative ideas and cost efficient ones. Overall, it is likely that each staff member should have a personalised package with a performance element that would be based on the assessment of a superior manager. In order to maintain some sense of objectivity, the criteria that the manager might use to judge performance should be agreed across the firm and could include, primarily, winning new business in tender competitions and, secondarily, winning industry awards.
Buying staff
The packages for the buying staff appear to be based on appropriate performance, although the setting of such targets depends heavily on the expertise of the finance team and, as they are based in the East office, they may lack the local knowledge to set the budget accurately. It may be wise to maintain the bulk of the buyers’ remuneration as a fixed salary element as a result.
Account management staff
It is surprising that this group of client -facing staff are not paid on performance. It would seem that their performance could be directly measured by client retention and new business won, so it would be common for such staff to have a high percentage of their remuneration based on performance and not be wholly fixed. Measures such as numbers of clients and total client revenues would be appropriate for these posts.
Administration staff
This is a common method of remuneration for these types of jobs and in line with the general market. A small bonus based on the overall performance of the firm may help to create a culture of loyalty throughout the business. It is unlikely to be efficient to set individual targets for such employees, given that there will probably be a large number of them.
